What Happens If the Loan I Cosigned for Goes into Default?

One in six American adults say they have cosigned for some type of debt, such as student loans, credit cards or car loans, according to a CreditCards.com survey.

A defaulted loan you cosigned for can ruin your credit, destroy your assets or retirement plans, and otherwise jeopardize your financial future. If a loan you cosigned goes into default, what happens is more or less the same as if you stopped paying on a loan you took out yourself.

  1. Credit reporting agencies will likely note the delinquent loan on your report and lower your credit score.
  1. Debt collectors may call you and send collection notices demanding repayment — potentially for large sums of money.
  1. Creditors may garnish your wages or obtain a judgment lien that allows them to seize your assets.

If you have a cosigned loan in default or at risk of defaulting, take action as soon as possible to mitigate these risks. Ideally, you’ll take steps before the loan recipient has missed a payment to prevent default.

What to Do If Someone Can’t Repay a Loan You Cosigned

Here are a few options to consider if the loan recipient can’t make payments.

Refinance or Consolidate the Loan

Work with the cosigner to remove yourself as a cosigner. Depending on how severe the default is or what the situation is, you may be able to refinance or consolidate the loan you cosigned for to remove yourself as a cosigner.

This is likely only an option if the person you cosigned for has decent credit, and the loans have not already become delinquent.

Make Payments Yourself

If you are unable to get the loan refinanced or consolidated to remove yourself as cosigner, consider making payments yourself to prevent delinquency or default. Making payments will keep the loan current and prevent the creditor from taking debt collection actions against you (or the recipient).

When you take over payment, work out a written plan with the person you cosigned for to make sure this doesn’t become a permanent situation.

Engage in a Strategic Default 

Depending on the size of the loan and your financial situation, engaging in a strategic default on a loan may actually be your best option. Before taking this route, speak with an experienced attorney.

Depending on your region, certain assets may be exempt from seizure or liens in the event of non-payment on unsecured debts (such as student loans). Some states also ban the garnishment of wages or other income sources. This may make you “judgment proof” — meaning, while you legally owe the money, a creditor may not levy payments against you or seize any assets.

While far from  ideal — in a worst-case scenario where you cannot make payments on the debt — strategic default may provide short-term relief.

Protect Your Finances

All of the above options are designed to try to minimize the damage from a tough situation. However, it is important to remember that, even if the person you cosigned for declares bankruptcy, you are still legally responsible for the loans unless you’ve refinanced or otherwise been released as a cosigner.

Given that every situation has unique circumstances, you should seek professional advice from a lawyer and financial adviser to determine what makes the most sense in your situation.